Did you ever wish when applying for a bank loan that you were the loan officer sitting on the other side of the table? Now you can be with Lending Club. Lending Club is a peer-to-peer (P2P) lending service lets you invest your own money.
With Lending Club they promise as possible a higher rate of return than many other traditional fixed-income investments. Compared to other types of investments, you have some ability to manage risk. It’s similar in class to bonds, but I like to think of it more as if you owned a bank and were the loan officer. You determine which loans you want to approve and which ones you want to pass on. Sound interesting? Keep reading for more details.
Though we have updated this review in light of recent negative news events.
Lending Club Borrowing Process
Some background on borrowing from Lending Club first. Applicants apply for a Lending Club loan online. The applicants must have a FICO score above 600. Over two-thirds of the loan applications get rejected by Lending Club. Only a small subset of individuals get approved, which is part of the risk management they perform.
Borrowers can apply for a loan from $1,000 to a maximum of $40,000. The interest rate is determined by Lending Club and based upon the applicant’s credit rating. Rates are very competitive when compared to traditional banks and start as low as 5.32% APR. The highest possible rate is 34.68% APR. The Best APR is available to borrowers with excellent credit.
The interest rate is fixed for the term of the loan. There are three- and five-year loans available. All loans are unsecured lines of credit and no different than credit card loans. Also, like credit cards, any defaults are reported to the three credit rating agencies (Equifax, TransUnion and Experian).
Lending Club Investing
Since this is a blog about investing, let’s discuss how to get started. The sign-up process as an investor is simple and takes a few minutes to complete. You can fund your account either via an electronic transfer from your bank or by mailing a check.
Once set up, Lending Club requires you must invest at least $25 per note. Notes are graded from A1 (lowest risk/lowest rate) to G5 (highest risk/highest rate), with subgrades per rate.
Lending Club Investing Requirements
Lending Club isn’t available to everyone as an investor either. As per requirements by the SEC and each state, Lending Club has a net worth and income requirements. Though Lending Club did not perform any means testing to ensure, I fit the requirements.
- Income Level — In most states, you must have a gross annual income of $70,000 or more and have a net worth of $70,000 or more. In the state of California, investors must have a gross annual income of $85,000 and a net worth of $85,000.
- Approved States — You can invest if you are you a resident of any state (as well as the District of Columbia) except the following: Arizona, New Mexico, North Carolina, Ohio and Pennsylvania
- Net Worth — If your total net worth is greater than $250,000, there is no annual income requirement. In the state of Kentucky, investors must qualify as an “accredited investor” under the Securities Act.
- Asset Allocation — Lending Club investors must not deposit more than 10% of their net worth in Lending Club notes.
- $25 Deposit — Only $25 is needed to start.
Lending Club Investing Risks
With any investment, even “secure” ones, you have risk. In summary, here are some possible risks when investing with Lending Club:
- Default Risk — Investments are not FDIC insured and not equivalent to bank CDs or Treasury notes.
- Inflation Risk — Similar to bonds since it’s a fixed rate, you have the risk of inflation eating at your returns. Though at the high rate of return of investments, this possible risk is minimized.
- Management Risk — Lending Club’s annual fee is 1%; this rate has already increased from, I believe, an initial 0.5% fee. This fee could increase in the future.
- Marketplace Risk — The risk that Lending Club goes bankrupt. While this is improbable given the history of Lending Club, it’s not impossible. Lending Club does have contingencies in place should they go bankrupt an orderly dissolve of the marketplace, but this has never tested.
- Callable Risk — Loans can be paid in full early and affect your return. The downside is you will need to find another loan to replace it.
- Diversification Risk — If you have a small amount of loans (less than 100), one default can dramatically affect your overall return. Ideally, you should have more than 400 notes (otherwise $10,000 or more) invested with Lending Club.
- Liquidity Risk — Loans can be sold on the secondary market, but it can take some time to unwind every single note. Lending Club is a long-term investment.
- Pricing Risk — Lending Club will properly price the borrower’s risk to default.
With the last issue, you can minimize this risk by specifically picking the loans you want to fund. You don’t think it’s a good loan? Don’t invest in that note.
Lending Club and Taxes
It should be clearly noted that Lending Club investments are not considered passive investments by the U.S. government. This means you cannot lock in the long-term capital gains tax rate. Therefore, the IRS taxes any profit as ordinary income.
If possible, you are best in a self-directed IRA retirement account. It is much more tax efficient than in a taxable account like I currently have. Lending Club does offer IRA investment accounts. A $5,000 minimum deposit is required to open a no-fee IRA. It is also possible roll over your existing 401(k) or IRA into Lending Club.
Lending Club Investing Strategy
Here’s what I do to maximize my return, yet try to minimize risk. Use how you see fit and do your own research before investing.
- Job Tenure — Look for someone who has had a job for a long time (10+ years being ideal),
- Government Job — Hold some sort of government position in local, state or federal.
- Low Debt to Income ratio — Make sure it is low (sub 30%)
- Debt Refinance — Go primarily for people looking to pay off higher interest rates, rather than the more riskier types of loans (like new businesses).
- Many Small Loans — Build up a portfolio of at least 200 notes. The more notes you own, the more even your portfolio’s performance will be. More notes help spread the risk out to many loans, should one default. Based upon this diversification, this then means a recommended minimum of $5,000 to invest. A total of 800 notes being the ideal investment strategy, which means $20,000 to invest.
- Loan Term — 36 months only. The additional 2%+/- return for 5-year notes in my opinion isn’t worth the additional risk.
- Interest Rate — Loans D through G only. I used to look at higher-quality loans with lower returns, but in my opinion, the risks didn’t justify the returns.
- Loan Purpose — I tend to focus on customers looking to get a better rate and reducing their debt
- Minimum Length of Employment — Greater than 1 year. The longer the employment, the better.
- Maximum Debt-to-Income Ratio — 30%.
- Credit Score — Greater than 678.
- Interest Rate — All. Though I trend toward selecting the higher rates. You should own a mixture of loan grades to increase and stabilize returns.
- Delinquencies (last 2 years) — None.
- Reviewed by Lending Club — Yes. I prefer that Lending Club has checked them over. It gives a better chance the loan will complete and that information is legit.
- Verified Income — Yes. At least as the initial search filter I perform. I also look at unverified income applications.
While I do make exceptions to the filtering, I tend to look at the big picture. The questions you should always ask are: “Will the individual pay back the loan?” and “Are they a good credit risk?” If you have any doubt in an application, skip it and find a better note.
If currently no good applications exist, wait a few days and check again. There is no need to rush the process. Take your time picking what you consider the cream of the crop, rather than getting stuck with a bad note. Once you purchase a note, it’s not so easy to unload it though there is a secondary market. In most cases, the goal of buying the note is to hold it for the life of the loan.
Lending Club itself has plenty of statistical information, and so does LendStats.com. Analyzing borrowing trends is something I recommend.
Should you want to unload a loan, there is a secondary market from Lending Club called FOLIOfn. This is great if you have a poorly performing loan or need cash for other investments. It’s also a great way to pick up notes from others selling.
In my opinion, though, this section of the Lending Club site is not too usable in its current form and needs drastic improvement. The searching options are simplistic at best and unlike their new loan search. If this section were improved, it could definitely increase the liquidity of Lending Club notes. There are some third-party services that do make these section of their service easier to use.
- Potentially Higher Returns — Possible to get higher returns than other types of traditional fixed income investments.
- Many Filtering Options — You determine which notes to invest in or which to pass on.
- Automated Investing — If you don't have the time or the knowledge you can hire Lending Club to do the leg work for you and invest your money automatically. You can also automatically invest based upon the custom filters you create. A plus is this costs nothing additional.
- Questionable Past History — Recent scandals at Lending Club have questioned the company and its business model.
- Untested Investment — While the notes are similar to consumer credit card debt, which we do have a lot of data on, it's still a new type of investment.
- Long Term Investment — Because notes are not liquid and the secondary market is just OK, it's a slow in-or-out of Lending Club investments
- Returns Are Not Fixed — Unlike a bank CD, returns are not fixed over the life of the note. Typical investors yield higher returns the first 1-2 years as notes mature. Note defaults will decrease returns.
- Not Everyone Can Invest — Unfortunately, Lending Club is not available in every state, or you must have specific income and net worth in order to participate.
- Gains Taxed As Ordinary Income — This is perhaps the biggest issue especially if you are in a high tax bracket. You are best to place Lending Club investments in an IRA account since you are taxed at ordinary income rates.
- 1% Annual Fee — Lending Club charges 1% annually per note you own within their marketplace.
I started with Lending Club in May 2009 with just $1,000 ($925 deposited, $75 in sign-up bonus) in my account. As of September 2015 stopped adding new money into Lending Club. At the time had over $22,000 invested and ROI was 9.34%.
As of today (August 18, 2016) have $9,541.19 remaining in my account with an ROI of 8.50%. At the time stopped adding new money in the service because of concerns about the economy and length of economy growth. It was not related to any news about Lending Club or questioning Lending Club’s business model at the time.
Of course, my returns with Lending Club might be unique and your specific results may vary.
In light of recent events, have removed Lending Club as a recommended service in the peer-to-peer investing space. I don’t question the viability of the business model, though the scandals put a major hindrance in the space for at least the short term. Based upon this as well have decreased the rating to 3 stars from previous 4 stars.
If you do invest with Lending Club do so in a limited matter, which is something I would recommend for any possible investment. Invest only what you can afford to lose.
Disclosure: I have over $9,000 invested in Lending Club notes.